Does cutting taxes create growth? Not so much

At one campaign stop after another, Republican presidential challenger Mitt Romney has been telling voters that "I know how to create jobs."

Mr. Romney has not yet disclosed the fine points of his plan, but the guts of it are tax cuts. In the short run he would maintain current marginal tax rates-including the 35 percent top rate on earned income and 15 percent on capital gains incorporated in the Bush tax cuts of 2001 and 2003.

In the long run, he wants to cut the corporate tax rate to 25 percent and simplify the tax code, making the top income tax rate 25 percent and eliminating as-yet-unspecified tax loopholes.

Inherent in these plans is the foundational conservative credo that cutting taxes creates growth. Unfortunately, the Congressional Research Service at the Library of Congress, which does research and analysis for members of Congress, has published a new report saying that since World War II, there is little evidence that cutting taxes promotes growth. But there is significant evidence that tax cuts have created more income inequality.

The cut-and-grow school has been around for a hundred years, but got its most thorough airing during the Reagan administration with the ascendancy of the supply-side economic theories of Arthur Laffer and the eponymous "Laffer curve."

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It sounds reasonable enough. The theory is that cutting taxes, particularly on those who pay the most, results in more money to invest and greater incentive to do so. This, in turn, would create a big enough pie that even the government would have more revenue than it would have had with higher tax rates.

Skeptics call it "trickle-down economics." In 1982, the liberal economist John Kenneth Galbraith called it "horse-and-sparrow economics," in that, "If you feed the horse enough oats, some will pass through to the road for the sparrows."

Alas, in a modern economy, the oats that pass through the horse don't necessarily have to land where the horse is standing. Investors can, and often do, choose to invest their tax savings elsewhere, either overseas or in financial products that churn money but don't create many jobs. Individuals amass great fortunes without becoming great industrialists. Companies today are sitting on $2 trillion in cash, which is a lot of oats.

Here is the key portion of the CRS report, written by Thomas L. Hungerford:

"Throughout the late-1940s and 1950s, the top marginal tax rate was typically above 90 percent; today it's 35 percent. Additionally, the top capital gains tax rate was 25 percent in the 1950s and 1960s, 35 percent in the 1970s; today it is 15 percent. The real GDP (gross domestic product) growth rate averaged 4.2 percent and real per capita GDP increased annually by 2.4 percent in the 1950s. In the 2000s, the average real GDP growth rate was 1.7 percent and real per capita GDP increased annually by less than 1 percent.

"There is not conclusive evidence, however, to substantiate a clear relationship between the 65-year steady reduction in the top tax rates and economic growth. Analysis of such data suggests the reductions in the top tax rates have had little association with saving, investment, or productivity growth. However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution.

"The share of income accruing to the top 0.1 percent of U.S. families increased from 4.2 percent in 1945 to 12.3 percent by 2007 before falling to 9.2 percent due to the 2007-2009 recession. The evidence does not suggest necessarily a relationship between tax policy with regard to the top tax rates and the size of the economic pie, but there may be a relationship to how the economic pie is sliced."

When the study was released two weeks ago, conservative critics noted how "convenient" it was for President Barack Obama's re-election campaign. It is hard to argue, however, that there is such a thing as "liberal" or "conservative" math.

It is not likely that returning the top marginal tax rate to 39.6 percent-as would happen if the Bush tax cuts are allowed to expire at the end of this year-would by itself kick off an era of growth. If cutting taxes doesn't yield growth, increasing them is not likely to do so, either.

The importance of the CRS study, as in similar studies by other nonpartisan groups, is to remind us that simple solutions do not answer in complex times.

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